What is Profit Margin?
Profit margin measures the percentage of revenue that turns into profit after deducting costs. Gross margin only subtracts direct costs (COGS), while net margin accounts for all expenses including operations, taxes, and interest. It is the single most important indicator of a business's financial health. See also the Markup & Margin Calculator for pricing conversions.
The Formula
Gross Margin = ((Revenue − COGS) ÷ Revenue) × 100 Net Margin = ((Revenue − COGS − Operating Expenses) ÷ Revenue) × 100
COGS includes raw materials, direct labor, and manufacturing costs. Operating expenses include rent, salaries, marketing, and administrative costs.
Worked Example
An e-commerce store has $100,000 in revenue, $30,000 in COGS, and $25,000 in operating expenses.
- Gross Profit = $100,000 − $30,000 = $70,000
- Gross Margin = ($70,000 ÷ $100,000) × 100 = 70%
- Net Profit = $100,000 − $30,000 − $25,000 = $45,000
- Net Margin = ($45,000 ÷ $100,000) × 100 = 45%
📌 The store keeps 70 cents of every revenue dollar after direct costs and 45 cents after all expenses, strong margins for e-commerce.
Why This Matters
Pricing strategy
Knowing your margins helps you set prices that cover costs and generate profit. Use the Break-Even Calculator to find the minimum volume needed.
Investor readiness
Investors scrutinize margins closely. SaaS companies with 70%+ gross margins are valued at premium multiples. Track these in your SaaS Metrics Dashboard.
Operational efficiency
Tracking margins over time reveals whether your business is becoming more or less efficient. Monitor your operating expense ratio for deeper insights.
Common Mistakes
❌ Confusing markup with margin
A 50% markup on a $100 item means selling at $150 (margin = 33%). A 50% margin means selling at $200. These are very different numbers that lead to very different pricing.
❌ Ignoring variable costs
Many founders only track fixed costs. Variable costs like payment processing fees (2.9%), shipping, and returns can eat 10-15% of revenue.
❌ Not segmenting by product
Average margin across all products hides underperformers. A product with -5% margin drags down your portfolio even if others are at 60%+.
Industry Benchmarks
| Category | Good | Average | Poor |
|---|---|---|---|
| SaaS Companies | 75-85% gross | 65-75% gross | Below 60% gross |
| E-commerce | 40-60% gross | 25-40% gross | Below 20% gross |
| Professional Services | 50-70% net | 30-50% net | Below 20% net |
Source: NYU Stern Damodaran Margins Database
Benchmark data sourced from NYU Stern Damodaran Margins Database.